If your fintech, financial services, or online lending company is looking to scale up operations and originate more loans or receivables, you may benefit from establishing a warehouse financing facility. A warehouse facility provides revolving financing to fund originations by pledging the underlying receivables as collateral until they can be sold or refinanced.
In this comprehensive guide, we’ll cover everything you need to know about warehouse facilities, including:
- What is a Warehouse Facility and How Does it Work?
- Key Benefits of Warehouse Financing
- Types of Assets Funded by Warehouse Lines
- Warehouse Facility Process and Timeline
- Key Terms and Structures
- Eligibility Criteria for Collateral
- Compliance and Reporting Requirements
- Risk Management Considerations
- Costs and Pricing Factors
Let’s dive in!
What is a Warehouse Facility and How Does it Work?
A warehouse facility (also called a warehouse line of credit or warehouse financing) provides short-term revolving financing to a company secured by the pledge of assets until those assets can be sold or refinanced. In lending, the assets being pledged are usually loans or other receivables originated by the borrower.
Here is a high-level overview of how a warehouse line works:
- Your company originates new loans or other receivables in the ordinary course of business.
- Instead of having to fund all of those originations from your balance sheet, you pledge the receivables as collateral to draw down a revolving credit facility with a lender, called the warehouse lender.
- The proceeds from the warehouse line are used to fund your loan originations. The facility revolves as you pay down advances made with new originations and existing receivables pay down.
- After a period of time, the pledged receivables are normally refinanced or sold to long-term investors in the capital markets. This pays down the warehouse line.
- The process repeats as you originate new receivables that can be pledged to finance growth.
Essentially, a warehouse facility bridges short-term financing needs between loan origination and when the loans can be refinanced or sold to investors. This provides debt capital for originations and asset generation instead of tying up your valuable equity capital.
Key Benefits of Warehouse Financing
There are several compelling reasons why many financial services firms utilize warehouse lines to help accelerate growth:
1. Fund Loan Originations and Asset Growth
The core benefit of a warehouse line is providing capital to fund originations, facilitating significant growth of your loan assets and revenues. Instead of funding 100% of originations from your balance sheet, you can leverage warehouse financing to keep equity invested in the business. This can support a higher volume of loan issuances and portfolio growth.
2. Bridge to Term Securitization or Refinancing
In addition to funding initial loan issuances, warehouse lines provide interim financing as you accumulate enough volume for term securitizations or whole loan sales. This bridging capacity can be essential for managing timing gaps between origination and term takedowns.
3. Preserves Equity Capital
As noted above, tapping warehouse financing lessens the amount of equity capital required upfront for originating new loans. This enables you to retain equity to fund operations, new products, technology, and other investments essential for growth.
4. Boosts Lending Capacity
The revolving financing capacity afforded by a warehouse line effectively increases your overall lending ability. You can scale originations much quicker since you don’t have to wait on infusions of equity or other long-term debt options which can take more time.
5. Covers Timing Gaps on Payments
Warehouse lines provide liquidity to cover timing gaps between when customers pay on receivables versus when you have to pay down financings. This cash flow timing flexibility is vital for managing working capital.
As you can see, utilizing a warehouse facility offers several advantages that enable faster origination volume growth while also providing flexibility to optimize equity capital and balance sheet management.
Types of Receivables & Assets Funded by Warehouse Lines
Warehouse financing facilities support funding for a variety of financial assets and lending products, including:
Consumer Lending: Personal loans, student loans, auto loans, credit cards, home improvement loans
Commercial & Business Lending: Small business loans, merchant cash advances, equipment financing, factoring finance
Specialty Finance: Structured settlements, healthcare receivables, marketplace lending
Mortgages: Residential and commercial mortgages
Essentially, if your business model involves financial lending and generation of a receivable, credit, or loan asset – a warehouse line can provide funding capacity leveraged against those obligations.
Warehouse Facility Process & Timeline Overview
The process of establishing a warehouse line is relatively straightforward but does require some time for diligence, documentation, and to operationalize the flow of funds. Let’s explore a high-level timeline:
1. Initial Discussions & Planning
- First connect with potential warehouse lenders to gauge interest and fit
- Provide necessary materials on your company, business model, projections, etc.
- Determine proposed facility size, key terms, structure based on business plan
Timeframe: 2-4 Weeks
2. Due Diligence
- Warehouse lender conducts thorough due diligence into your operations, policies, procedures, financials, projections, etc.
- Assess ability to manage facility, effectiveness of risk controls, collateral quality
Timeframe: 4-8 Weeks
3. Term Sheet Issued
- After satisfactory due diligence, the lender provides a proposal with indicative terms for credit approval
Timeframe: Varies
4. Documentation Process
- Negotiate final facility agreements and contracts with lender
- Establish accounts, execute security filings, and operationalize collateral flows/reporting
Timeframe: 4-8 Weeks
5. Funding & Operation
- With paperwork completed and accounts readied, the facility can fund and operate per established contractual terms
Timeframe: Immediate upon closing
While the entire end-to-end process can take 3-6 months, it’s important to start conversations early and plan for the timeline involved. With proper planning, you can time availability of the warehouse facility in synch with your growth trajectory and origination pipeline.
Key Terms in a Warehouse Financing Facility
Warehouse lending facilities have a variety of structural terms that are important to understand:
Advance Rates
Typically 75-90% initially, dictated by asset quality. Advance rate against pledged collateral. May step down over facility tenor.
Facility Tenor
1-3 years. May be sized up over time. Allows for program ramp, season, and refine policies.
Funding Mechanics
Dictates mechanics of funding advances and releasing sold/repaid collateral.
Eligibility Criteria
Dictates criteria pledged assets must meet to qualify as “eligible” for funding. Everything from obligor parameters to documentation standards.
Concentration Limits
Caps maximum % of facility that can be backed by certain larger obligors, industries, etc. Manage risk pools.
Interest Rates & Fees
Pricing for usage fees, non-utilization fees, collateral management fees, etc. Typically indexed to benchmark rate (SOFR) plus spread.
Financial Covenants
Maintain minimum equity, profitability, liquidity + other metrics tied to performance.
Collateral Triggers
Early performance warning signs that trigger additional actions, such as collateral over-collateralization.
Representations & Warranties
Statements about adherence to policies, procedures, compliance, etc. Contractual assertions about collateral quality.
Reporting Requirements
Information and statements provided on periodic basis showing facility status, compliance, collateral details. Supports monitoring.
Events of Default
Contract clauses listing events that allow the lender to terminate facility access or require immediate repayment – e.g. covenant violations.
Make sure to scrutinize these terms during negotiations to craft agreement optimized for your needs and cost of capital.
Warehouse Collateral Eligibility Criteria
In order for pledged assets to qualify as eligible collateral under a warehouse facility, they must meet outlined eligibility criteria per the agreements. This protects the interests of the lending institution.
Typical eligibility criteria rules for loans may include:
- Must conform to written credit policies and underwriting guidelines approved by the facility lender
- Must be current – no delinquencies, defaults, bankruptcies, or other distressed status
- Cannot be extended to an obligor already significantly past due with the lender
- Must be denominated in facility-approved currencies (typically USD)
- Minimum payment amounts and frequencies
- Maximum tenors, balances relative to income, total exposure to borrower
- Certain loan types excluded (e.g. modifications, workout programs, etc.)
- Collateralized up to LTV ratios (for secured lending)
- Duly documented with executed notes and security agreements
Receivables/merchant cash advance eligibility often entails
- True sale from originator to borrowing entity
- Underlying business must be operating and solvent
- Maximum advance relative to monthly receivables or revenue
- Requires payment processing via lender accounts
- Personal and validity guarantees from receiving entities
Ineligible assets above certain thresholds could trigger covenants or events of default if not addressed. Thus, collateral eligibility is a key consideration under warehouse agreements.
Compliance, Reporting & Audit Requirements
In order to monitor the assets and maintain collateral controls, warehouse lenders establish various compliance, reporting, and information management obligations required to be met by the borrower, including:
Compliance Requirements
- Advance Rate Compliance – Ensuring advances don’t exceed established rates
- Concentration Limits – Complying with caps on certain large obligors, segments
- Eligibility Criteria – Pledged collateral continues meeting eligibility standards
- Financial Covenants – Performance metrics like liquidity, profitability stay intact
Reporting Requirements
- Portfolio Reports – Status updates on assets, delinquencies, losses, concentrations, etc.
- Borrowing Base Certificates – Documentation of eligible collateral and allowable advance capacity
- Financial Statements – Periodic income statements, balance sheets, cash flow statements
- Compliance Certificates – Statements from management asserting satisfaction of financial covenants, representations and warranties, or other contractual obligations
Audit Requirements
- Collateral Audits – Periodic inspection of pledged assets and underwriting files to ensure compliance and accuracy of reporting
- Operational Audits – Assessments of policies, procedures, risk management controls by auditors
What you report and staying compliant with terms is vital for continued access to warehouse financing capacity. Failing to meet obligations could trigger assumptions of elevated risk and reduced funding access.
Risk Considerations With Warehouse Lending
While warehouse lines provide a valuable funding source for fintech lenders, relying on facility advances to finance operations does introduce business model risk factors to contemplate:
Potential Loss of Funding Access
If covenants are breached or problems arise preventing compliance with warehouse agreements, the lender may reduce advance rates, prevent future advances, or terminate facility access altogether. This could severely impact liquidity essential for making loans and necessitate urgent backup funding plans.
Magnifies Mark-to-Market Valuation Effects
If pledged loans or other assets drop significantly in secondary market value, this may prompt warehouse lenders to change advance rates or borrowing bases used to calculate funding capacity. This could reduce available liquidity.
Liquidation Sales May Still Carry Losses
In a default or early wind down scenario, the collateral assets may still need to be sold to institutional investors. If this occurs during distressed periods, it further magnifies losses from having to liquidate at discounts to par value carrying cost.
Survival Depends on Backup Funding Options
Because warehouse debt is short term in nature, firms must develop reliable secondary liquidity sources to refinance maturing debt. This requires cultivating institutional investors, alternative funders, or other sources to tap if required.
The business risks above highlight why companies utilizing warehouse finance should maintain sufficient equity capital, cash reserves, and backup funding avenues in case market dynamics change.
Warehouse Facility Costs and Pricing
The main costs associated with getting a warehouse line established encompass:
Upfront Fees
Origination Fees – Upfront points paid on initial facility commitment, around 0.75-1.5% of size
Legal Fees – Expenses related to documentation drafting and negotiation
Due Diligence Fees – Costs absorb by borrower for lender audits, collateral reviews, etc.
Account Fees – Charges for specialized collection and lockbox accounts
Ongoing Fees
Interest Expense – Interest paid based on benchmarks (e.g. SOFR) plus a spread ranging from 3-10%+ depending on structure/risk
Non-Use Fees – Assessment for unused capacity, around 0.375 – 1.5%
Servicing Fees – Charges deducted from interest income for facility administration
Backup Servicing Fees – Charges for contracted backup servicer to monitor portfolio and data
Other Miscellaneous Fees – Assessments for amendments, waivers, etc.
The overall cost of funds depends heavily on the risk profile, track record, performance history, market conditions, and leverage capacity of the borrower. More established companies with strong equity cushions and long operating histories can achieve more competitive overall pricing.
Conclusion
For high-growth financial services, online lending, and fintech companies, warehouse lines can serve as rocket fuel supporting aggressive portfolio growth ambitions. By pledging short-term assets like loans and receivables to access revolving funding capacity, firms can put less reliance on selling equity or tapping long-term institutional debt to fund customer acquisition.
However, companies should also be prudent in leveraging warehouse facilities by maintaining rigorous risk policies, diversified backup funding options, close performance monitoring, and sufficient liquidity buffers. Used judiciously as part of a balanced capital funding strategy, warehouse financing allows businesses to scale efficiently by generating assets funded with mostly debt rather than equity.
The process of putting a warehouse line in place takes some lead time for planning, documentation, and launch. But with robust collateral performance and disciplined execution, warehouse credit facilities offer a powerful funding engine to catapult enterprise growth.